Learn more about peer-to-peer lending:

How does peer-to-peer lending work?

Have you ever let a friend or family member borrow money? Well, that's a small form of peer-to-peer lending. One of your peers needed money, you offered a loan.

This idea has led to an entirely new lending industry that matches people who want loans with people who are potentially willing to fund those loans. The matching is done via an intermediary - a peer-to-peer lending service.

Peer-to-peer lending on the web

Peer-to-peer services work in different ways, but typically it's all website based. Borrowers list their request on the peer-to-peer lending website, then you as the investor, browse the website to decide which loans you will invest in.

Sometimes websites will show details of specific loans - for example 'Peter wants $10,000 to help pay for his wedding - he'll pay 7% interest'. Lenders may be able to lend the full $10,000 loan, or just a portion of it. At other times the service may group up similar loan requests so the lender has the opportunity to invest in a variety of loans at one time.

Typically the service sorts out the administration, for example, for the money to go from you to the borrower (or borrowers), dealing with repayments and interest payments, and chasing any defaults. Some services will do more or less than others, so make sure you read the description of the service carefully.

Borrowers have to abide by certain rules such as being honest about the information they provide about how they will use the money and their ability to pay it back. They can borrow a maximum of $2 million in any 12 month period, although some services may only allow smaller loans.

Licensed peer-to-peer lending services have been checked by us and have to follow rules around presenting information clearly. They must have systems in place to assess whether the individuals, companies, community groups and charities who want to borrow money are at risk of non-payment, such as running credit checks.

It's very important you ask the service about the level of checking they have done. We don't check the financial health of borrowers or any information you may get from the lending service.

They must also have a system in place to handle complaints and belong to an independent dispute resolution scheme.

Licensed peer-to-peer lenders have ongoing obligations to continue to comply with the standards they met when we licensed them.

What information must you receive?

For investors, the offers on a peer-to-peer lending website might look a bit like a series of fixed interest term deposits. But they can work in very different ways to traditional term deposits.

The disclosure statement. This tells you things like how the service works, the fees you'll pay, and the checks the service has and hasn't done on the borrower(s) you're lending to.

The client agreement. This is your contract with the service provider, outlining the terms of your agreement.

Make sure you read the information you get, particularly the information about the checking the service has done on the borrower. We don't do any checks on borrowers, or the information the service provider gives you.

Also read the explanations of how the service works that the website itself provides so you understand things like how you can get your money back early if you need it.

Check whether the loan you are investing in is to one person or an organisation or whether it's been spread across a number of borrowers - different risks apply.

The risks involved in peer-to-peer lending

Every investment has risk and dealing with risk is a normal part of investing. It's important you understand that with peer-to-peer lending your investments are actually a loan direct to a peer, so different risks apply. Here are some points to keep in mind:

It's not the same as putting money in a bank

You may be offered a higher interest rate than offered by your bank, but this is because you take more risk. The risk you're taking is that the borrower(s) may be unable to repay you, rather than your bank being unable to repay you. Make sure you read the information the peer-to-peer service provides to help you assess the risk of non-payment.

You could lose your money or not get the interest you've been promised

Your investment is actually a direct loan to an individual or an organisation, so if they don't pay it back, you're unlikely to get your money back.

Some services offer ways to reduce this risk - such as spreading your loans across more borrowers, or guaranteeing the repayments themselves. These services don't eliminate the risk of losing your money. Even where the repayment is guaranteed you will only receive repayments if the person or service providing the guarantee has enough money to pay.

It may be difficult to get your money back quickly

Unlike some other investments, you may not be able to sell the loan or withdraw your cash whenever you want. If you're lending money you need to make sure you can afford to have your money tied-up for the period of the loan.

If you want to re-invest you may have to wait

At a bank you can often roll over your term deposit as soon as it falls due - with peer-to-peer lending you may need to wait until there are peers who want to borrow it. You may miss out on some interest while you're waiting.